On October 23, 2013, the SEC published additional crowdfunding rules that give insight to the rules and procedures required to raise money through equity crowdfunding to non-accredited investors (typically, Accredited Investors being individuals with over $1 million net worth or $200,000 per year income). This type of crowdfunding has been widely hailed as knocking down barriers for young start-up companies to raise some funds – in the case of crowdfunding under $1 million in a 12 month period – to enable them to get off the ground.
Let’s take what I expect to be a typical example of a company considering crowdfunding – a young, fast-growing company looking to raise $250,000. The following are the requirements the company will have to satisfy to take advantage of a crowdfunded financing.
- These raises can only be accomplished using the services of a broker/dealer or authorized funding portal. This will require a fee.
- The company must provide financial statements reviewed by an accountant – a further expense.
- The company must file an annual report with the SEC and provide it to its investors.
- At the end of the raise, it is very possible that the company may have a very large number of equity holders, which could complicate its capitalization table and make administration and compliance with law with respect to these holders more expensive and time consuming. If the company needs to raise more money in the future, this could cause some issues.
I realize that often these companies do not have access to funding sources, but if at all possible, I would say that a good old-fashioned friends and family Regulation D fundraising would be a better alternative. It would not result in any of the disadvantages listed above. If access to “friends and family” willing to support the company’s efforts is not possible, the new SEC regulations permitting a general solicitation under Regulation D are another alternative. Though a Regulation D General Solicitation can only be made to Accredited Investors and some additional hoops may be required to ensure the investors qualify as Accredited Investors, like crowdfunding, such an offering can be done through a website or general advertising but does not require the disclosure and filing requirements listed above. Plus, an Accredited Investor should be able to write a larger check, thus hopefully resulting in fewer investors.
One exception, which may apply to some franchised businesses, is, like the product-type crowdfunding of the past, crowdfunding can be used to create “buzz” around a company. Time will tell, but if a company wants to get a lot of publicity, putting itself “out there” on a crowdfunding site may help accomplish that goal. Not sure yet as crowdfunding is too young.
I would strongly encourage all considering crowdfunding to consult with their legal and financial advisors before taking this important step.